MNI BOE WATCH: BOE Hikes By 50, "Watchful" On Inflation

The Bank of England hiked rates as expected by 50 basis points to 4.0% at its February meeting, though tempered its tightening with softer guidance as the Monetary Policy Committee removed an earlier warning from its statement that it would take “forceful” action if need be.

While the change in guidance and inflation forecasts in the quarterly Monetary Policy Report seemed to suggest that a cycle peak in rates could be near, Governor Andrew Bailey and deputies Ben Broadbent and Dave Ramsden told a press conference that inflation risks remain to the upside and that uncertainty was high. They made no attempt to talk down a market curve that points to rates peaking just over 4.5%.

The MPR forecast showed that even if Bank Rate is left on hold at 4.0% headline CPI inflation would fall below the 2.0% target, dropping on the modal, or most likely, path from 9.72% this quarter to 0.83% in Q1 2025 and to just 0.19% in Q1 2025.

But Broadbent rejected the interpretation that this meant rates had peaked, saying that they were “still very watchful … (with) risks very clearly to the upside."

The mean, or simple average, inflation forecast was close to the 2.0% target on market rates in two years' time, at 1.75%.

The MPC’s relative silence on the market curve marked a return to usual policy after a surge in expectations for the rate peak to 5.25% in November prompted Bailey to suggest that the real figure was likely to be about 4%.Declining to comment on market pricing, Ramsden said “normal service has been resumed.”

POTENTIAL GROWTH

Bank economists also revised down their estimate of the UK’s potential growth from the previous 1.5%, to just under 1% initially and then to 0.7% in the final and third year of the forecast horizon. (See: MNI POLICY: BOE Eyes UK Trend Growth As Labour Force Tightens).

The key driver behind this move was weaker potential growth in the labour supply, which was attributed to a mix of an ageing population and declining participation rates, with rises in long-term sickness and early retirement. Many who had left the workforce were unlikely to return, the Bank concluded in a labour market stocktake.

The UK has been hit by a succession of shocks, Ramsden said, stressing that their effect on potential supply was uncertain and could be greater or lesser than the Bank has estimated. The baseline assumption is that even 1% yearly growth would be inflationary, however, and Broadbent also noted that a higher energy prices path than currently assumed could add one percentage point to inflation at the end of the forecast period.

The minutes of the MPC's February meeting revealed a continuing split within the MPC, with Swati Dhingra and Silvana Tenreyro both voting for unchanged policy. The majority though considered that higher rates were justified by the tight labour market and elevated inflation expectations, and put more weight on recent labour and prices data rather than on the Bank's medium-term growth and inflation projections.

The Bank also raised its growth forecasts to show a shallower recession, with the economy shown contracting 0.5% in 2023, up from an earlier estimate of -1.5%, and by 0.25% in 2024.